Inside Wall Street's Factory of Fakery

Discussion in 'Wall St. News' started by Greg Richards, Feb 5, 2009.


    Inside Wall Street's Factory of Fakery – February 5, 2009
    By Elizabeth MacDonald

    Third in the Crackdown on Wall Street series

    Law enforcement officials say arrests on Wall Street will be made not just by those who hawked predatory loans, but those who sold predatory securities built on those as loans well, interviews with Justice Dept. officials denote.

    Namely, the bonds and derivatives compulsively minted by Wall Street’s financial engineering factory, where bad mortgages, bad credit card payments, bad auto loans, bad student loans, you name it, were sluiced through the underwriting pipeline and magically emerged as Triple A rated securities, safe as a US Treasury.

    Bonds and derivatives that were sold by companies purposely set up offshore in places like the Cayman Islands or Guernsey, away from the prying eyes of regulators.

    The credit rating agencies are under scrutiny, too, as the push was on to get these radioactive securities goldplated Triple A, meaning safe and virtually risk-free, because both Wall Street and the credit rating agencies knew full well that investment portfolios around the world, notably pension funds, by the very dint of their own regulations were only allowed to invest in safe, Triple-A rated securities.

    It’s clear Wall Street went wild. It manufactured trillions of dollars in asset-backed bonds and derivatives that dwarfed the value of the underlying mortgages, auto loans, and student loans on which they were based, investment experts say.

    The mayhem was notable inside the offices of the Wall Street underwriters of what are called collateralized debt obligations (CDOs), pools of bonds which are backed by pools of mortgages, and so on.

    Bucket Shop Bonds

    When you invest your money, you expect a competent money manager who will protect your investment, right?

    However, too many investors in these mortgage-backed and other asset-backed bonds invested on autopilot, without checking who was watching their money.

    Specifically, the securities and derivatives under scrutiny were supposed to be overseen by competent investment managers to ensure investors money was protected and returns were being paid.

    Anything less is a breach of fiduciary duty, and potentially securities laws, says Janet Tavakoli, derivatives expert and author of “Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street” (John Wiley & Sons, 2009).

    So who were these guys who oversaw these jerryrigged bonds?

    Executives you wouldn’t want managing your local McDonald’s, notes Fox Business’s Joanne Ossinger.

    And the deals were filled with so many rotten heads of lettuce.

    An Unregulated Bond Factory

    Derivatives expert Tavakoli says that in November 2006, she warned a Wall Street shop that “their CDO managers are unregulated,” that “most do not have the expertise or the resources to perform CDO management or surveillance,” and that “many cannot build a CDO model.”

    She also noted that “rating agencies rarely ask for background checks on CDO managers.”

    Many prospectuses for these securities offerings read like “finance comic books,” Tavakoli says she wrote in a letter to legendary investor Warren Buffett in December 2007.

    A Rotten Deal

    Tavakoli says one notably rotten deal came across her radar screen. In late 2006, she read the prospectus for a mortgage-backed security that took hundreds of mortgage loans, shoved them into a portfolio, and sold the risk to investors.

    The portfolio included negative amortization loans and interest-only loans, the most combustible mortgages bought from some of the worst mortgage mills that have since flopped.

    In these mortgages, because principal is not being paid down, the loan amount steadily increases and then the interest rate shoots up, with a massive balloon payment that is similar to the levees breaking in New Orleans, Tavakoli says.

    More than 60% of the loans backing this security were purchased form New Century Capital, which in turn bought them from New Century Mortgage Corp., a unit of New Century Financial Corporation, an incestuous stew of a company that restated its financials in February 2007 and then filed for bankruptcy on April 2, 2007, under a cloud of fraud allegations, Tavakoli says.

    Merrill Lynch Goes Full-Bore

    Merrill Lynch was Wall Street’s biggest underwriter of CDO deals built on loans such as these, derivatives built on loans from places that were essentially mortgage mills.

    For example, Merrill Lynch was a part owner of California-based Ownit Mortgage Solutions, a mortgage mill that eventually collapsed in December 2006, Tavakoli points out.

    Ownit issued crazy 45-year ARMs and no-income-verifications loans. In the words of William D. Dallas, its founder and CEO: “The market is paying me to do a no-income-verification loan more than it is paying me to do the full documentation loans.”

    Michael Blum, Merrill Lynch’s head of global asset-backed finance, sat on the board of Ownit Mortgage Solutions. When Ownit imploded in December 2006, Blum faxed in his resignation, Tavakoli says.

    Full Steam Ahead

    But Merrill continued to sell derivatives based on Ownit’s loans well into 2007, Tavakoli says.

    For example, in early 2007, Merril created a package of securities deals including loans issued by Ownit, Tavakoli says.

    However, around 70% of the borrowers of the loans had not provided full documentation of either their income or assets, Tavakoli says. Most of the loans were for the full appraised value, meaning they were no down payment loans, loans given at a time when home prices were already starting to crumble.

    In the deal documents, says Tavakoli, Merrill disclosed that Ownit went bankrupt, but did not mention it was Ownit’s largest creditor.

    Can Merrill say it did an “arms-length” transaction with Ownit when a Merrill officer sat on the Ownit’s board, Tavakoli asks?

    In early 2007, both Moody’s Investors Service and Standard and Poor’s, the credit rating agencies, downgraded the Triple-A rated tranche of the deal, “an investment they had previously rated as ‘super safe’ with almost no possibility of loss) to B (junk status meaning you are likely to lose your shirt),” Tavakoli says.

    Moody’s later forecast that 60% of the original portfolio value could eventually be lost, Tavakoli says.

    However, the SEC as a regulator of the investment banks had the power to stop this nonsense, but it did nothing to halt this securitization activity. “Instead, investment banks accelerated securitization activity in the first part of 2007,” Tavakoli says.
  2. wave


    "Merrill Lynch was Wall Street’s biggest underwriter of CDO deals built on loans such as these, derivatives built on loans from places that were essentially mortgage mills."

    Are you saying they "Merrilly Lynched" the public?

    Lets not forget Shitibank(Citibank) as well.
  3. They make Madoff appear insignificant.
  4. Mvic


    More Wall Street shit that the SEC turned a blind eye to for so long, only focusing on the small retail or celebrity insider trading rather than those on the tsreet they were supposed to be monitoring.

    Isn't Blackstone supposd to be helping the Fed dispose of the toxic assets? Because we can trust them not to screw us right?
  5. LOL what? That's a generous appraisal.

    Those "assets" are barely worth anything.
  6. You are very wise. Of course it was generous. The estimate was provided by a government appointed oversight panel.
  7. Tom Patrick former chairman (and former CFO) ousted from Merrillin 2003 was on CNBC today. In Tavakoli's book mentioned in the MacDonald article (Dear Mr. Buffett) she said loan losses for subprime/AltA/prime that were from bad mortgage products woudl reach $450 billion. Patrick said that 3$452 billion of mortgage loans in that category are 30-day delinquent.

    He said "Merrill committed suicide" from June 2006 to March 2007 and ramped up their super seniors from $4 billion to $60 billion without selling a bond. MacDonald quotes Tavakoli's book explaining how Merrill hid the lower rated tranches while holding the "safe" super senior stuff and getting bond insurers involved to make it look like it offloaded risk, but it all boomeranged back on balance sheet just like Tavakoli said it would.

    I put this link on another thread, but here it is again, because Greg Newton's review of Dear Mr. Buffett: What an Investor Learns 1,269 Miles from Wall Street is a no-punches-pulled review: